An Overview
Ashok ji was retiring as General Manger with a private company. He was quite satisfied with his life planning. In 2005 , he had invested in a pension plan of an Insurance company. He has been saving Rs 2 lakh per year for the last 15 years with a promise of a monthly pension of Rs 50000 since age 60. He also got approx. Rs 20 lakh from PF and gratuity. Ashok ji visited an Insurance company to understand the procedure of collecting a monthly pension of Rs 50000.
Ashok ji was shocked to know that there is no pension of Rs 50000 but he will get an annuity of Rs 20000 per month. This would also come from a new contract as the earlier Pension contract is over. Ashok ji and his wife were feeling cheated and did not know what to do next.
Victor had invested Rs 1 Crore in an annuity plan with a monthly annuity of Rs 50000. Unfortunately, Victor expired in 2020 under COVID.
His wife Mary visited an Insurance company to withdraw Rs 1 crore as she was planning to shift to Australia along with her son. Mary and her son were shocked to know that no money is payable as Victor bought an annuity for life which had no scope of return of capital. Mary was cursing the Insurance company.
There can be many stories around Pension or annuity because people buy these products for old age but they feel cheated when the real need arises.
Pension products are sold with many wrong promises about pension or annuity amount. Such commitment is wrong and misleading and causes dissatisfaction towards insurance products.
So let us understand Pension and Annuity Products:
- Pension: Pension is a benefit by the employer where contribution is made each month so that a regular income is assured after retirement. So Pension is a regular income post retirement. As it is an assured benefit hence such planning is called Pension Scheme or plan. Mainly it was offered under employment but today it is offered by Insurance companies as Pension Plan to ensure pension in old age. It also means that Insurance Companies only accumulate money for old age financial security. Today it is offered to all so that people plan old age pensions like Government employees.
- Annuity: Annuity plan is an insurance concept which covers the risk of living too long. Annuity guarantees a pension till one lives or as per the contract agreement. It is called reverse of life insurance here Insurance company gains if death happens early. Hence annuity is an insurance contract.
Pension Plan
- Pension plans only accumulate funds for old age. This can be easily compared with schemes like NPS / PPF / Endowment which also accumulates funds for a purpose. All have similar tax benefits under Section 80C. Only NPS offers extra Rs 50000 under section 80 CCD (1b ). So in NPS, one can get a tax benefit of Rs 2 lakh.
- At the time of maturity of the Pension Plan, one can withdraw 60% of the amount as tax free income but 40% of the accumulated amount has to buy an Annuity Plan. This restriction ensures that some money is blocked for use of the old age Pension.
- This accumulation earns interest in two ways:
- Traditional system where Insurance Companies offer a yearly bonus which is resultant of earning of pool. Please note that insurance companies pay commission and have expenses so only 85% of invested amount goes in a pool of funds. Nett return will be in the region of 4-6% hence Pension plan maturity would be lower in comparison to PPF or similar product.
- Unit linked system (ULIP )where each investment buys units as per the choice of fund. Aggressive investors choose Equity and risk averse investors go for balanced or safe categories. Here again only 90% is invested post expenses and commissions. So NPS compares much better as an accumulation tool. NPS offers better tax benefits, less expenses and efficient fund management.
- After accumulating funds for Pension, this accumulation is called Purchase Price of annuity plan. Annuity rates can not be guaranteed at the time of purchase of a Pension Plan. Annuity rates will be guaranteed only at the time of purchase of Annuity contract because it will be determined on the basis of prevailing interest rates. So mis-selling takes place at the time of sale of Pension Product with commitment of an assured pension. Please note Pension plan and annuity plan are two mutually exclusive contracts.
Annuity product
1. Annuity is an insurance contract which comes in two types:
- Immediate Annuity – where pension begins immediately
- Deferred Annuity – where pension begins on a fixed date
2. Annuity contract can also be made as per defined purpose:
- Annuity for life – here pension would be given till annuitant lives. Pension stops the day an annuitant dies. As this comes with huge risk, hence Insurance companies offer the best rate of Pension.
- Annuity for life with return of Purchase Price – It also works the same way as Annuity for life but Purchase price is returned to the nominee. As it works like a fixed deposit, the lowest pension is offered under this scheme.
- Annuity for self then after death to spouse and return of purchase price to nominee.
- Annuity for limited period then for life: Here guaranteed pension is given for affixed period irrespective whether live or not. After a fixed duration, pension would continue till death of the annuitant.
3. Annuity rates would also depend on payment cycle. It would be maximum under annual mode and lowest in monthly mode.
4. Annuity contract is different from Pension Plan and mostly a new policy is sold at the time of annuity where seller earns commission and company gets money for expenses. Government also takes tax so buyers lose from all angles.
Bottom Line
Once we understood Pension and Annuity, let us decide the action plan for building a plan for pension:
- Prefer an ULIP or NPS for accumulation of funds. Choose an aggressive fund if you have over 10 years.
- Begin early , you need to give more time in the market.
- Decide your monthly requirement then decide on purchase price.
- Choose Annuity for self then spouse with return of purchase price.
- Choose an annual mode of annuity then plan expenses.
Buy Pension plan and annuity after long research and your needs. May be Ashok ji or Victor would have not suffered if planning was done with care.
By: Shailesh Kumar
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